What are the Differences Between the Top Four Retirement Accounts?

Planning for retirement can be a stressful task, mainly the aspect of saving up money to be able to retire can be the most daunting. This is why choosing the right retirement account to hold your savings makes a big difference and can give you the peace of mind you need. However, because there are various types of retirement accounts that each have their benefits and limitations, you may be asking yourself- which account suits me best? To begin answering this question, you may want to first, set a concise savings goal and be informed on all your options to see what retirement account would best help achieve your goal. 

What are the Differences Between the Top Four Retirement Accounts?

Here is some insight on the top 4 most common retirement accounts and their differences:

1) 401(k) Plan

A 401(k) is one of the most common types of retirement accounts that an employer offers its employees. This account allows you to put portions of your pre-tax paycheck in and have it be tax deferred, which means it will not be taxed while you're growing your savings. This also reduces the amount of income taxes you pay. For example, if you make $85,000, and choose to deposit $5,000 into your 401(k), you will only be taxed on $80,000. Generally, 401(k)’s can contain any type of investment, but usually the company you work for will provide you a selection of investments. Investments put into the account also grow tax deferred. However, it is important to know that if you withdraw any money from your 401(k) before the age of 59 ½, you may be subject to a 10% penalty, as well as state and federal taxes on the withdrawal. There are some cases where 401(k) plans allow for a loan if you ever find yourself in an emergency and in need of some funds. A major benefit of this type of account is that it allows for company matches, which means some companies may offer to match a percentage of your retirement contributions into your 401(k). In addition, unlike other retirement accounts, 401(k)’s offer a high contribution limit. As of 2023, you're allowed to contribute up to $22,500, and if you are 50 years or older, you can contribute up to $30,000. 

There are 2 main types of 401(k) plans:

  • Traditional 401(k)- With a traditional 401(k), your account is funded with portions of your pre-tax paycheck and grows tax-deferred. However, you will have to pay taxes on withdrawals taken out during retirement. 
  • Roth 401(k)- With a Roth 401(k), all your contributions to your account grow tax-deferred and you do not have to pay taxes on withdrawals taken during retirement. However, this solely applies to your contributuons. If your company chooses to match your contributions, it will grow tax-deferred and you will pay taxes on only the matched portion withdrawn from the account during retirement. 

2) 403(b)

A 403(b) is a retirement account generally given to those who work at a nonprofit or tax-exempt organization, this includes public school employees, government employees, church employees and charity workers. This account works very similarly to a 401(k) because both have contribution limits of $22,500, and if you are 50 years or older, you can go up to $30,000. Employers may also offer matches to your contributions. All contributions made to the account will be tax-deferred, but withdrawals will be taxed during retirement. If you choose a Roth 403(b) option, which works the same as a Roth 401(k) mentioned earlier, you will only pay taxes on the matches withdrawn during retirement. Similarly to other retirement accounts already discussed, penalties will be incurred if you withdraw money before you reach the age of 59 ½. If you withdraw money before reaching this age, you may be subject to a 10% penalty and state and federal taxes. However 403(b)’s do tend to have lower administrative fees. 

3) Traditional IRA

A traditional IRA is a retirement account that is solely managed by you, meaning you open and fund the account by yourself. This gives you the benefit of full control over your investments which can be made in the form of stocks, bonds, ETFs or even real estate. Similar to previous retirement accounts, all contributions and investment gains will be tax-deferred until withdrawn during retirement and can reduce your income tax for that year. There are also no income limits for contributions, you can put money in no matter what your income is. In addition, the same penalties apply, if you withdraw before the age of 59 ½ you may be subjected to a 10% penalty and state and federal taxes. However, what makes this account different is its contribution limits. The 2023 contribution limit is $6,500, but if you are 50 years or older you can contribute up to $7,500. Also important to note, with a traditional IRA, money cannot be held in the account forever, withdrawals need to start being made at the age of 72.

4) Roth IRA 

A Roth IRA similarly to a traditional IRA is solely managed by you, therefore you are in charge of making all decisions in regards to your investments. There are also the same contribution limits of $6,500, and $7,500 if you are 50 years of age or older. What makes this retirement account different is money invested in this account are after-tax dollars, meaning money put in the account is tax-deferred and you will not have to pay any tax on withdrawals made during retirement. While this does mean your income taxes will not be reduced when investing your money, this does avoid any taxation on withdrawals upon retiring. 

An important difference to note is there are income limits for contributions. For 2023, the income limit for joint married couples is $218,000 and $138,000 for those filing individually. There are also no penalties for early withdrawals from this account, given that 5 years have passed since your first contribution. Savings in the account can also be stored for your entire life, and you can continue contributing even after the age of 70 ½.  

Learning about the different types of retirement accounts is the first step to take when choosing what type of account fits you best. If you need any guidance in making this big decision,  contact the Law Office of Inna Fershteyn at (718) 333-2394.

Law Office of Inna Fershteyn and Associates, P.C.
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